We have written before of our respect for the ability of Andrew Haldane, Chief Economist of the Bank of England, to express in readily understandable ways, ideas that others cannot or will not. So, we were delighted to read his latest speech (“Stuck”, published on June 30th), in which he discussed the relevance to the currently “stuck”-on- the-floor level of policy interest rates of “dread risk”, an elevated perception of risk which can persist for long periods, affecting human behaviour in a variety of ways. As an aside, we would suggest looking at Chart 5, which purports to show that current interest rates are the lowest in recorded history, over a timeline dating back to 3000 BC (sic!). At Awbury, we really enjoy looking at the sweep of economic and financial history, not that any of us can recall quite that far back!
However, what is important about Mr. Haldane’s speech is his evidence that “dread risk” and the resulting paradox of thrift and caution have lingering and non-benign consequences; not only holding back productive investment, but creating something of a mania for supposedly “safe” assets, in which demand has consistently overwhelmed supply. The Great Recession is in many ways the Great Depression Redux, as economic recovery has been sluggish and interest rates stay close to (or even below) the zero-bound floor. Psychological scarring heals only slowly (one only has to look, in a broader sense, at the aftermath of 9/11); while events in the Eurozone merely serve to exacerbate risk aversion. In spite of record low nominal interest rate levels, and real rates also close to zero in much of the world, investment levels are below trend, further compounding the effect of slower rates of economic growth. In short, much of the world is in a “funk” and reluctant to invest or spend.
Paradoxically, this is not necessarily irrational. In another section of his speech, Mr. Haldane points out and evidences that the probability of a further recession within any 10 year period on a cumulative basis is almost 90% since 1870; and 80% since 1970. So, depending upon how one dates the nadir of the Great Recession, the probability of another one across those areas which have so far avoided Euro-malaise or specific local factors (such as Brazil) is not insignificant. After all, the Great Moderation turned out to be something of an illusion in terms of its outcome!
The problem, of course, that central banks face is that, when the next recession comes, the traditional tool of lowering interest rates may not be available; and (a further paradox), raising rates in the near term (as the Fed is increasingly likely to do), may actually increase the probability of another recession (or at least decline in rate of GDP growth) occurring.
It is, indeed, a strange world in which we find ourselves – one in which the “traditional” tools of monetary policy increasingly do not work; but in which no-one has yet come up with realistic alternatives.
– The Awbury Team”